November 2009

RBS directors threaten to resign

Published on: 29 Nov 2009

In terms of examples of risk management and corporate governance, UK based banking group Royal Bank of Scotland (RBS) just gives and gives.  It’s an unfolding story that continues to grow.

RBS was a big success story in the last decade, showing very fast growth and taking over bigger banks such as Nat West.  Its considerable returns appear to have been won, rather predictably, by taking a high level of risk.  Previous blog entries have mused on the wisdom of having fired their risk manager.

The banking group was saved from collapse by receiving vast emergency support from the UK government.  This was controversial but almost everybody agrees that it was necessary in order to avoid a collapse of the entire banking system.  Such a collapse would certainly have made the recession very much worse.

The British public thus became an involuntary shareholder in RBS.  Indeed, the UK government now holds a controlling interest in RBS, though it’s been keen to avoid interfering much in the management of the bank.

The image of bankers in the UK at the moment is very tarnished. Most people who have an opinion on senior bank staff have an unfavourable opinion; often seeing them as people who were over-rewarded for taking excessive risks.  Many resent having to bail out a bank ruined by unwise risk management.

So it came as a surprise to many when the directors of RBS said that they intended giving bonuses and pay increases to many staff last week.  This provoked anger from the government and outrage from the public. The RBS board stated that they would resign if they weren’t allowed to pay the bonuses, as failing to pay people well would result in loss of talented staff.

It has to be questioned whether the board have ever studied stakeholder management and the Mendelow matrix. With 70% of the ordinary shares, the government is a key player; the views of the public must be respected.  If that means the synchronised departure of the board of RBS, so be it.  Bankers’ salaries and bonuses have been in an inflationary spiral in recent years and some bank must be the first to bring their salaries into the realm of sustainable expenses.

It will be interesting to see if the directors follow through on their threat, back down or are even removed from office by the shareholders (ie the government).  Whatever the outcome, their credibility is arguably much tarnished.

IFRS 9 released. This is a biggie.

Published on: 29 Nov 2009

On 12 November 2009, the IASB issued IFRS 9 “Financial Instruments”.  This is the first stage of a three stage project that will probably make or break the international reputation of the IASB and its deeply impressive chairman, Sir David Tweedie.

The IASB inherited IAS 32 and IAS 39 from its predecessor, the IASC.  IAS 32 and IAS 39 have been rather markedly unloved ever since their introduction.  IAS 39 in particular has been criticised for taking fairly complicated financial transactions and making them more complicated still with piecemeal rules for different types of transaction.  Although it definitely had its supporters, many people said that the perceived complexity of IAS 39 made it insufficiently understandable by most people to be much real use.

Here at ExP, we believe that IAS 39 has had a slightly unfair press over the years.  It does have its faults for sure, but it also has a decent logic at its core.  The new IFRS (which will come in three parts over the next year; the next two stages to deal with impairments and the third phase to address hedging rules) has a tough job.  Make the rules simpler and it will create loopholes that will be exploited by creative accounting.  Close every possible gap and it will result in an accounting standard that puts on weight each year with minor amendments and ends up not understandable.

The attempts at simplification are honourable.  We’ll wait to see with interest how well they work.  But well done to the IASB for keeping calm in the global financial crisis that many commentators blamed the accountancy profession for making much worse.  They were under huge pressure to make change and they appear to have done a good job in the time they had available.

The Biggest Rights Issue in UK history

Published on: 29 Nov 2009

F9 and P4 students should be aware that there are a variety of ways to raise finance (see chapter 4 of our free F9 ExPress notes. One method is by way of a rights issue where a company issues new shares and sells them to existing shareholders. Shareholders are not obliged to buy them but merely have the “right” to buy them. By being given the “right” they have the security of knowing that their shareholding won’t be diluted by shares being issued to other shareholders without first being offered them.

The Lloyds Banking Group has recently announced the UK’s largest ever rights issue and the bank hopes to raise over £13 billion. Press reports state that the main reason behind the rights issue is to raise sufficient funds to avoid the bank having to take part in the government’s banking insurance scheme that was set up after the recent banking troubles in the UK.

This is going to be an interesting one to watch. Lloyds has nearly 3 million shareholders with the majority being private shareholders. Whether or not these shareholders will be willing to take up these rights remains to be seen. They are due to meet to approve it this coming Thursday. In the run up to the exam though I’m sure students will have more to worry about than the outcome of this vote but make sure you’re aware of the various finance raising methods for the exam!

Shutting the stable door

Published on: 29 Nov 2009

A UK director of one of the Big 4 firms pleads guilty to false accounting and fraud, having fraudulently claimed more than £500,000 in expenses in order to finance his wife’s extravagant lifestyle!

The director told police that he had stolen the money because “he did not want her lifestyle to suffer”, being afraid that she would divorce him. Apparently his fraudulent claims were kept below £5,000, meaning that they did not require further authorisation!

A spokesman for the firm said:

“Mr Wetherall’s frauds were detected via our own internal checks and he was dismissed in 2008. A thorough internal investigation was carried out and the case was then handed over to the police.”

The firm also stated that they had changed their internal procedures to prevent such fraud being committed again.

That could be useful I guess when advising client’s on their internal control systems in relation to expense claims!

Companies Act 2006 Provisions now in force

Published on: 29 Nov 2009

A number of provisions from the Companies Act 2006 finally came into force with the final implementation of the Act on 1 October 2009.

However, the Act has been examinable in the F4 Paper for some time, albeit the examiner has expressed some concern about candidates still answering questions with reference to the old legislation.

It is very important therefore to ensure that your study materials are up to date.

As an example, one of the provisions which has just come become effective in practice is the changed allowable uses of the Share Premium Account.

Use of share premium is now restricted, so that only the premium arising on a specific issue of shares is available to write off any expenses or commission associated with that issue.

It is no longer possible to use an existing balance on share premium to write off the costs of a new issue of shares. Neither is it possible to use the share premium account to write off any formation expenses nor to write off costs/provide for premium associated with the issue/redemption of debentures.

British Airways and Iberia – suitable, acceptable but is it feasible?

Published on: 25 Nov 2009

In last week’s P3 ExPand video I talked about the recent announcement of the British Airways (BA) merger with the Spanish airline Iberia. Some form of merger had been discussed on and off since they held talks in the summer of 2008 but now it’s looking like there could be some movement on this.

Students of Paper P3 will be aware that Johnson & Scholes argue that when evaluating strategic options, 3 major areas should be considered. Namely, is it suitable, is it acceptable and is it feasible?

The aviation industry is extremely competitive. In the current economic environment it is safe to say that the merger would help both companies in terms of synergies and hence from a suitability point of view it appears to work.

This issue of acceptability would need to be examined in the context of the key stakeholders of the firms. BA is quoted on the London stock exchange so some key stakeholders would be some of the big shareholders. The share price rose by 7% following the announcement so the shareholders appeared to like the news.

The final area is that of feasibility. An important issue from the feasibility point of view is whether it would get regulatory approval from the European Commission.

It’s suitable, it’s acceptable but is it feasible? Let’s wait and see what develops.

BA and Iberia to merge. Except not.

Published on: 22 Nov 2009

British Airways is a big airline and so is Iberia; the flag carrier airline of Spain.  Both have experienced considerable difficulties in recent years with the global recession greatly reducing revenues and causing operating losses.

For nearly two years, the two airlines were in discussions about merger, in order to share routes and operating fixed costs.  The deal was finally announced in mid November 2009.

The deal is that the two airlines will fuse to create a new business with the working name of Topco. Topco’s capital will be 55% owned by BA’s shareholders and 45% by Iberia’s shareholders. The board will meet in Spain and the CEO of BA will become the CEO of the new business.

For accounting purposes, mergers don’t exist. There is always an acquirer and an acquiree; respectively being the controlling party and the controlled. In this situation, we accountants see it that BA has just done a deal to acquire a new subsidiary, called Iberia.  Assuming that Iberia’s shareholders agree to sell.  And before that happens, there’s the minor issue of BA’s huge deficit on its defined benefit pension scheme to sort out. IAS 19 produces some deeply unattractive pension liabilities on BA’s statement of financial position.

Anyone got a spare £9.8bn ?

Published on: 18 Nov 2009

Mergers & Acquisitions (M&A) are an important part of the ACCA P4 syllabus and are also featured in CIMA F3. Those of you that have read our free ExPress notes (/expand/17-p4_advanced_financial_management.html) will be aware that to minimize the risk of failure in the M&A process, acquiring companies should follow a systematic series of steps prior to launching a bid.

Namely:

1. Clarify strategic reasons for wanting to acquire a company;
2. Draw up a short list of possible takeover targets and select the preferred one;
3. Value the target based on publicly available information and to establish an opening bid;
4. Identify financing options for the transaction

There has been a lot of coverage recently about the attempt by the American food producer Kraft to acquire the British chocolate maker Cadbury.  After Kraft announced their intention to acquire Cadbury, another company (Hersey) announced their interest in acquiring Cadbury.

The sums of money involved are significant. Identifying financing options for the acquisition (point 4 above) is therefore going to be key. Kraft’s bid is £9.8bn and press reports indicate that a syndicate of 8 banks has been brought together to finance the approach. The interesting thing though is that it is reported that these 8 banks have been tied into a non-compete agreement. This means that Hersey cannot approach the same banks to finance their approach. As a result it is going to be more difficult for Hersey to raise such amounts of funds.

Whatever happens over the next few weeks this will be an interesting story to follow.

It’s music to the ears…

Published on: 15 Nov 2009

I’m a keen concert goer and enjoy listening to all types of music. In my opinion one of the most pleasing sounds on the ear is that of a piano.

Last month, Kemble and Co., the only remaining large scale UK piano manufacturer stopped production in the UK. Its main shareholder Yamaha transferred operations to Asia.

Whilst there is a debate amongst music aficionados around the world as to whether the sound of instruments is different depending on where it was manufactured, what is interesting from a strategy paper point of view is to think about why Yamaha made the decision to transfer production to Asia. There could well be a question in the exam involving relocating production to another country. So why did Yamaha move the production location?

The reason is clearly due to cost savings due to economies of scale, synergies and utilising spare capacity at some of their other production facilities in Asia.

In 2 years time, Kemble is due to celebrate its 100th birthday. It will still celebrate its birthday but they will be blowing out the candles on the cake in Asia and not the UK.

Was the audit evidence sufficient and appropriate?

Published on: 15 Nov 2009

It could be very interesting to see how this one develops!

A UK accountancy group signed off the 2007 accounts of one of their audit client companies, having accepted the valuation of £11 million for one of its assets, a ruby known as “The Gem of Tanzania”.

In the previous year’s accounts, a different firm of accountants had accepted the valuation of the same stone at £300,000.

On the basis of the £11 million valuation the owner of the company, came to the rescue of another company Wrekin Construction. Wrekin Construction was subsequently put into administration earlier this year and the administrators, Ernst & Young, looked to have the ‘ruby’ valued.

It turned out instead of being the world’s most valuable ruby, it was in fact a lump of anyolite worth in the region of £100!

Bet those previous auditors are not sleeping very well right now.

Still it would make a really nice paperweight!

The ExP Group